Insurers must be really hurting


#1

Rates have been painfully low for insurers since the GFC, but they were starting to pick up a bit until… Brexit happened.

With rates at the short end stuck at zero, Brexit has cause a hard-to-imagine downward slope in yield curves from already low levels. This must really be hurting insurers with unhedgeable long-dated liabilities who were already feeling some pain.

Brexit may reveal which insurers have been swimming naked.

Any thoughts?


#2

where do they put their low risk, liquid funds? Today it is short dated US Treasuries or cash deposits. Not only Insurance facing this problem, but its huge for them. One answer is Payables Finance for AAA rated buyers aka Supply Chain Finance - short dated, low credit risk, self liquidating. But that is not happening at scale yet.


#3

Most of insurer’s assets are already liquid, not just short-dated assets, e.g. 30-year treasuries. One investment theme I’ve always thought was good for insurers is to monetize some of that liquidity in the form of long-dated illiquid investments with high credit quality such as infrastructure projects. Another favorite of mine is ECA loans that are typically government backed, but the backing is tied to a specific counterparty so they are illiquid.

If you ask an insurance risk officer how much liquidity is in their asset portfolio, they’ll respond, “A lot!” But before you can think about monetizing liquidity through these types of illiquid investments, you need strong liquidity risk management to be able to quantify exactly how much liquidity you really have over a range of scenarios.

Unfortunately, the easy solution most institutional investors go for in these low interest rate environments is the search for yield by going down the credit spectrum. That rarely ends well.


#4

But Trade Finance loans via ECA are short term and self liquidating. That is why Banks have always loved Trade Finance. Know any Fintechs going after that opportunity?


#5

More on the subject:

“If this situation continues, we’ll have a state of emergency, in particular for life insurers”

I tend to agree. I think we could see some serious trouble here.


#6

One question that should be considered by regulators is the cost to society of much tighter regulations (Solvency II) which are driving insurers to go into very low yield assets such as government debt. This is disrupting the corporate equity and bond markets. Security for policyholders is clearly important, but the impact on capital raising for growth causes broader societal issues (eg low growth, higher government borrowing at low / zero yields).


#7

Hi @DaniKatz,

I’m sure you know EIOPA has a reason for Solvency II and that purpose is not to drive insurers into low-yielding assets, but to protect policyholders and protect the solvency of the company. Insurers are not investment companies and should make money from pooling and managing insurance risk and not from investment returns from taking credit and equity risk. Leave that to money managers.

I have talked to the regulators here in HK about the new RBC framework they are considering. One unintended consequence of the old solvency margin regime is that insurers in HK are incentivized to take credit risk (because liabilities are discounted roughly at portfolio yields) and a new RBC framework that did penalize credit risk appropriately could lead to a market selloff and the credit market in HK is not very deep, so this is something to think about, but I would lean the other direction. Less credit risk and equity exposure for insurers. Not more.

Cheers,
Eric